Author：PSE Trading Trader @MacroFang

Fed says Recession is no longer on the cards

Fed Outlook: A Soft Landing Anticipated

The Federal Reserve is expected to steer towards a soft landing according to the minutes released today. While the minutes indicate optimism and determination to bring inflation back to target, the officials are likely to remain cautious about a drastic policy shift due to slower inflation readings and growing downside risks to growth. This stance is unlikely to dampen the financial conditions.

The Fed’s policy, which currently leans towards managing growth risks and financial stability over inflation, is not expected to alter significantly.

Even with a heightened focus on growth, there is an assurance that equal attention is given to both aspects of the dual mandate. As softer inflation readings make this balance easier, forthcoming stronger inflation may pose a challenge, potentially disrupting the balance as rate cuts become a harder sell for the Fed amidst growing risks to growth.

US Equity: Sees SP500 Rallying to Record Levels in 2024

Bank of America strategists forecast a record high for the S&P 500 in 2024, as U.S. companies effectively navigate increased rates and macroeconomic disruptions. The rise is attributed to the Federal Reserve’s previous actions, rather than future cuts. Boosted by a resilient economy and an end to profit recession, the S&P 500 has rallied 18% this year. Savita Subramanian, leading the strategists, suggests that earnings can increase even if economic growth decelerates. With most investors still bearish, other analysts see further upside potential, predicting a continued rally.

Federal Reserve Maintains Stance Amid Economic Concerns

The US Federal Reserve is currently maintaining its stance on interest rates, despite rising risks to growth and inflation. Recent data show an upward trend in jobless claims and unemployment, suggesting the intended dampening effect of higher interest rates on economic activity. However, an anticipated recession looms for the following year, and the inflation rate is expected to exceed its target. Despite these circumstances, the latest official stance does not signal an intent to either hike or cut rates until a more significant slowdown in economic activity occurs. The increasing detachment of inflation expectations poses a concern for Federal Reserve officials.

Indications of Economic Slowdown and Inflation Acceleration

Emerging signs point to a potential slowdown in economic activity, contrasting with currently resilient activity data (estimated 2.2% Q4 real GDP growth). Federal Reserve officials interpret this combination of strong activity and softer inflation as reasons for optimism towards a soft economic landing. However, these conditions may coincide rather than indicate a stable macroeconomic outcome. A significant rise in housing prices has been observed, although there has been a slowdown over the last two months, possibly due to increased mortgage rates dampening demand.

Initial jobless claims declined by more than what was expected to 209k from 233k during the week of November 18. Overall, the 4-week initial claims moving average remains at low levels and points to the pace of layoffs not picking up much. Continuing claims declined for the first time in about two months, down to 1840k from 1862k during the week of November 11. Half of the decline in seasonally adjusted continuing claims was due to an abnormal drop in Puerto Rico claims which should rebound in coming weeks.

Fed Communications: No Further Rate Hikes

In the near future, data and Federal Reserve communications are expected to affirm the prediction that no further rate hikes will occur in this cycle. An anticipated softer increase in core PCE in October aligns with this view. Also anticipated is a pullback in new home sales due to elevated mortgage rates. Conversely, the supply-demand imbalance in the existing homes market will likely continue to exert pressure on home prices. The ISM Manufacturing index is expected to rebound, partially due to the resolution of autoworkers strikes in November. Federal Reserve Chair, Powell, is not expected to bring much new information to the table but will likely underscore the cautious approach of the Federal Reserve alongside a readiness to raise policy rates if necessary.

FOMC Minutes: Rising Treasury Yields = Dovish Stance

The minutes from the Federal Reserve’s FOMC meeting on November 1, 2023, reveal that the Federal Open Market Committee is apprehensive about the rising Treasury yields and their potential impact on growth and financial stability. Policymakers have pledged to maintain “sufficiently restrictive” financial conditions, but their strategy is cautious. This means they aim to avoid a quick tightening of financial conditions, but won’t resist easing. Despite inflation expected to remain above target in the coming year, no further rate hikes are anticipated in this cycle. Before the meeting, Fed officials had indicated that the increasing ten-year Treasury yields, nearing 5%, would be cause to reconsider a planned 25 basis point rate hike later in the year.

The minutes further suggest that the rising Treasury yields are perceived as a threat to financial stability, with banks in particular facing losses on their portfolios of fixed-rate assets. The reaction to the rise in long-term yields varies amongst the Fed officials. They acknowledge the slowing of recent inflation, but require more data to be confident that inflation is on track to return to the 2 percent target. While officials agree that the labor market is becoming better balanced, they are uncertain if the rising labor supply will be a sustained trend. Some have also pointed out that wage growth is faster than what is consistent with 2% price inflation. In conclusion, the FOMC agrees that policy rates should move carefully, with the likelihood of an increase in policy rates being low.